The merits of a debt money system

In my previous post I explained how the Western world's debt money system works.  Currently, in our system, all money is created as debt. Debt precedes savings: it is lent out by financial intermediaries and becomes someone else's savings when it is spent. Therefore, contrary to popular opinion, for someone to have savings it is necessary for someone else to have debt. And because debt (in its widest sense, so including corporate equity) and savings are equally balanced over the economy as a whole, when debt is paid off savings are reduced by an equal amount.

In a debt money system the value judgements so frequently applied to debt and savings are unhelpful and can lead to completely inappropriate courses of action being taken by individuals, corporations and - particularly - by governments and supra-governmental organisations such as the IMF. Popular morality, particularly in the Anglo-Saxon world, has it that debt is a BAD thing and savings are a GOOD thing. These mores may be helpful when teaching fiscal responsibility to teenagers. But they are meaningless when applied to a debt money economy.

In a debt money economy, both debt and savings are necessary. Savings cannot exist without debt, and because of the way fractional reserve banking works, new debt cannot be settled without savings. It is completely circular and, as I noted above, economically balanced.

Socially, however, it is far from balanced. The fact is that most of the savings are held by richer people, and most of the debt is held by poorer people, or by governments on behalf of poorer people.  And as a couple of people pointed out in the comments stream on this post, the imbalance is also inter-generational. Older people tend to have more savings, of all kinds, than younger people do, and conversely younger people tend to have more debt than older people. The commentators on Positive Money's post describe this incorrectly as a wealth transfer from younger to older. It is nothing of the kind: people build up wealth by saving from their lifetime's income, so it is inevitable that people who have lived and worked longer will tend to have more wealth (savings) than younger people. These savings are lent back to younger people to enable them to have things such as cars and - yes - houses that they do not yet have the wealth to be able to afford.This transfer of savings from older to younger, and from richer to poorer, to enable younger and less wealthy people to have a better standard of living than their present wealth would permit is in my view one of the principal benefits of a debt money system. Yes, that debt has to be paid back from future income, and if future income disappoints in relation to the money borrowed then paying back that debt can become very difficult. But as a way of redistributing wealth on a temporary basis it works pretty well.

The opposite of a debt money system is a saved money system. An increasing number of people, including (but not limited to) Positive Money, are calling for changes to the Western debt money system which would amount to transforming it into a saved money system. In a saved money system, money is created through payments, not through debt, so savings precede debt.  And because savings precede debt, it is of course not necessary for debt and savings to balance.  Money stuffed under mattresses or buried in the ground never gets lent to anyone, so debt will tend to be less than savings.

Intuitively a saved money system "feels" better to many people, because it's how they've always thought the money system worked - partly because banking and economic textbooks incorrectly teach that savings precede debt in fractional reserve banking.  And it fits better with the mores I described above: if savings can exceed debt - as they can in a saved money system - then Anglo-Saxon moral judgements about the evils of debt and the wisdom of saving can be applied with impunity.

But there is a huge problem with a saved money system. You see, it discourages lending to all except safe risks - which generally means people who already have wealth, not people who don't but might have in the future. This is because whereas in a debt money system savings don't exist unless there is debt, so there is a tendency for debt to increase, in a saved money system not only do savings precede debt, they can exist without it. In a saved money system lending is entirely optional and hoarding is very, very tempting, and in hard times people can be very reluctant indeed to lend. In a saved money system therefore, debt tends to be much lower than it would be in a debt money system.

Now, I can hear you all saying "but less debt, more savings is a good thing, surely"? No, it isn't. Remember that in a debt money system, the lifetime savings of wealthy (older) people are recycled through their investments back into lending to poorer (younger) people? That redistributive function is much less certain in a saved money system, particularly if money supply is kept tight to control inflation. The result is that instead of poorer (younger) people financing a better standard of living (and the start of saving) through debt, they are likely to have to fund far more of their major purchases from income alone, by "saving up for them". This is particularly the case if the older generation are applying value judgements to savings and debt, so are unwilling to lend to younger people unless they already have good incomes and savings - which sort of defeats the purpose.  In a saved money system therefore I would expect to see levels of evident material poverty, particularly amoung the young, that in a debt money system would be mitigated by the use of debt. The wealth inequality between the richest and the poorest would be on show for all to see. Is this what we really want?

The other way of redistributing wealth between rich and poor is of course tax and benefits. But the older to younger distribution is much less effective here. In fact in most advanced tax systems there are transfers in both directions - from older to younger in the form of state education and benefits aimed at younger people, such as child benefit: and from younger to older in the form of state pension and benefits aimed at older people, such as free bus passes and fuel allowances - not to mention the fact that older people are much heavier users of a national health service than younger ones.  If we moved to a saved money system, to mitigate the evident poverty of younger people intergenerational transfers would have to be skewed considerably in favour of younger people, for example by heavy taxation of equity held in property. And hoarding would have to be systematically discouraged, for example by heavy taxation of investments deemed "unproductive" and enforced contribution to forms of saving considered "socially desirable".  I have seen proposals along these lines, but all of them depend on there being a far more authoritarian and invasive system of government than we currently have. Is that what we really want?

Neither a debt money system nor a saved money system is perfect, and neither can be left to run on its own. In a debt money system left to run on its own, debt generates more debt until eventually the debt levels overwhelm the economy and the population ends up in debt peonage. In a saved system left to run on its own, obscene wealth is juxtaposed with grinding poverty, older people who have done well in life hoard their savings while younger people - and older ones who have been less fortunate - starve.

I see no benefit in changing to a saved money system, and potential for great harm in the level of authoritarianism that would be required to mitigate the wealth/poverty imbalance through taxation and coerced lending. I would rather retain our debt money system, with all its faults, but seek to put in place an effective brake on its tendency to generate more debt, and limits on the lending practices that create this tendency. This to my mind is the function of government.  In recent years governments have been increasingly "hands-off" with regard to the regulation of money creation through lending. This is not freeing the market to do its best - it is abdication of responsibility.

It may be that even with brakes such as tighter lending standards and taxation of bank balance sheet expansion, debt will still get out of hand from time to time. The "debt jubilee" proposal which is doing the rounds at the moment is an idea from early Jewish culture, in which debts were wiped out every seven years and people in debt slavery were able to return to their families. It may be that we, too, need to consider introducing routine writeoff of debt after a certain period of time, or a general wipeout of debt every few years. But we shouldn't be blind to the cost of this. When you wipe out debt, you also wipe out savings. And life being the way it is, you can absolutely guarantee that it won't be the excess savings of the very rich that will be wiped out. It will be the pensions and savings of ordinary people. Steve Keen's idea seems to be that government should step in to protect those savings - but is that really a jubilee, or is it just borrowing from a future generation to protect the current one?

Whatever system of money we have, the real issue is the growing wealth imbalance in our society. And unless we address that, the same problems will return again and again.  The more wealth is concentrated in a very small number of people, the more everyone else has to borrow to have a decent standard of living (in a debt system) or the more poverty-stricken they are (in a saved money system). Changing the money system solves nothing.


  1. It is an interesting conundrum; how do you manage inequality to make debt sustainable?

  2. Great post, Frances; I find your blogging very thought provoking. Thanks for sharing!

    On intergenerational/wealth imbalances... I really liked Steve Waldman's take on the morality of NGDP targeting, and how it deals with malinvestment. Essentially that inflation is the best way to deal with investments which turn out to not be productive. But "inflation" must be defined in terms of income, not prices.

  3. Anonymous,thanks. I'm planning a blogpost on inflation shortly, so that link to Steve Waldman's work will be useful.

  4. As I commented previously the debt money system has a serious disadvantage of being potentially unstable (as per my previous comment on a previous blog).

    However that aside there are two issues in this article that I would like to understand better. You state that a debt based money system enables wealth transfer, but surely this comes with a cost namely interest which is passed from borrower to saver.

    Whilst this may not be a problem for assets that have growth associated (e.g. a young company) with them, it is a problem with assets that don't offer a yield or growth such as housing (a major proportion of household debt). Also as there is a limited supply of housing, houses themselves act as a system for transferring wealth from people who purchase last (e.g. young families) to people who have already purchased (e.g. older people).

    Equally I would also question your claim that debt based economies are better at transferring wealth to people without a credit history. Surely half our recent problems were caused by exactly this (e.g. subprime mortgages)... suggesting that although the system may try to achieve this and may in theory be better than a credit system, actually its not really very good at this.

    Would be interested to get your feedback!

  5. Hi Anonymous,

    The debt money system has existed for a very, very long time - as the anthropologist David Graeber pointed out in his recent book, it goes back into prehistory and possibly pre-dates actual money. So it can't be that unstable, can it?

    The problem is that as I pointed out, debt tends to generate more debt until it overwhelms the system and has to be wiped out along with savings. Boom and bust is an inherent part of a debt money system in the same way that feast and famine is an inherent part of a credit money system. That's why according to the Bible routine debt forgiveness was built into the debt money system of the Jewish nation - and that's the bit we have forgotten about.

    Wealth transfer in the form of debt is not without cost - after all, savers need to be compensated for not spending their savings. That doesn't invalidate the mechanism, though. As I pointed out, the only other mechanism that can transfer wealth is taxation, which is considerably less effective because the levels of taxation of older people with illiquid assets that would be required to replace debt would I think be politically unacceptable. Taxation isn't exactly cost-free, either.

    There is an element of wealth transfer from younger to older in the sense that older people benefit from the future mortgage payments of younger ones. I don't agree that housing doesn't give a yield - as a long-term investment property is a fairly high-yielding low-risk investment. Your problem is that the yield from housing doesn't benefit anyone but the owner, whereas a growing company would benefit others. There is therefore a case for taxing the appreciation of equity in property. But the real problem is, as you point out, supply of houses. Just think through what effect restricted supply of houses would have in a credit money system where people only lend to safe bets. Who do you think would be able to buy houses?

    Debt systems are very, very good at transferring wealth to poorer people. Too good, actually - they have a tendency to lend too much to the wrong people if not regulated - which as I said in the post, I believe is the responsibility of government. There does need to be a brake on excessive lending. But that doesn't invalidate the system itself.

  6. Do you have any evidence of the theory about credit money, as is it just assertion. I'd be interested if you could point me to any research - it sounds like an unbacked assertion to me. Thanks.

  7. Ariel

    I've already pointed you to Positive Money's website in this post. Their proposals amount to introducing a credit money system. You should also look at the Still Report from the United States, which also proposes a credit money system. And you should look at Tax Research's proposals for a nationalised banking system, which would have a similar effect. The essence of all their proposals is that banks would be reserve constrained rather than capital constrained (which I have written about in my previous post on this subject - link at the top of this post) and money would be created IN ADVANCE of lending by government, rather than appearing as a consequence of lending. If money is created in advance of lending the system is in effect savings-led, which is a credit money system.

    I admit that this is an area that I am still researching myself, as I would like to see if there are any credit money systems in operation in the world today. I have heard that some Asian economies have savings-led money systems, and Sharia law requires savings to lead debt (although how strictly this is applied in Islamic banking I'm not sure).

  8. I probably worded my comments on housing yield and growth incorrectly. However I agree with you that increasing house prices only benefits the owner. However I would go a step further and say that if the cost of housing grows faster than the economy in general it actively disadvantages the young whilst offering big dividends to speculators. The speculators who win the most will be the people who brought in first. This effectively means the young face a double whammy of paying money to older speculators whilst also borrowing from the older generation!

    Anyway you say that debt based systems are good at transferring money from rich to poor. Certainly there is evidence of this with the recent credit crunch (and irresponsible lending to people who couldn't pay). However arguably this was caused by the system not functioning and risk not being properly analysed. Assuming this were not the case, is there any evidence of a well regulated debt based system being better at transferring wealth than a credit based system?

    Additionally is there any evidence that the wealth transfer in the last debt bubble actually advantaged the poorest. I would have thought that there was a good argument that the poor were often offered a false dream that only served to enrich real estate company and banks speculating on debt packages.

  9. Anonymous,

    Any properly functioning money system can effectively redistribute weatlh through debt. It doesn't matter whether the system is a credit system or a debt system as long as it works properly. Problems arise when the money system doesn't work properly. As you point out,a debt system that doesn't work properly results in too much debt, especially for the poor. But a credit system that doesn't work properly results in not enough debt, especially for the poor, which means the redistributive function breaks down and people end up in terrible poverty. Some debt is a good thing, remember, so a credit crunch affecting the poor is very bad news. It is the job of government to regulate the money system to prevent it becoming dysfunctional. Whether the system itself is a debt system or a credit system is irrelevant.

    Positive Money and others are quite wrong to suggest that a credit system would be problem-free. It actually has the potential to create problems that are just as bad, and just as difficult to solve, as a debt system. Therefore changing the system is pointless. Government should be turning its attention to ways of stabilising and managing the present debt system to minimise its tendency to create bubbles.

  10. Thanks for your response. It would seem the choice is between a debt based system that can malfunction badly (as recent events demonstrate) and a government based system (and hoping they get it right more often than not).

    I think I still tend to side with the positive money view whilst (more) aware of its limitations. It seems to me that the current system puts way to much power in the hands of banks (who like all companies are interested in generating returns for themselves) and leaves the governments as weak external regulators. Forcing banks to buy debt from the government would very much strengthen the hands of the regulators and government (and ultimately mean we could hold people to account if a economic disaster did happen).

    Anyway I remain moderately open to arguments about why such a strategy could never work.... I just haven't yet heard them.

  11. Anonymous,

    The main problem is precedence. At present money supply responds to lending demand. Under Positive Money's proposals government would have to forecast that demand sufficiently accurately to avoid a credit crunch while keeping inflation under control. Government forecasts of inflation, GDP etc. are notoriously inaccurate, aren't they? What makes you think that they would be any better at predicting money supply needs? Demand for money can only be accurately predicted in a zero-growth command economy where government controls both the means of production and the availability of credit.

    Positive Money's idea that banks can still control lending in a credit money system is fatally flawed, because short of issuing the MPC with a crystal ball there is no way they could ensure that banks had available the exact amount of money the economy would need in advance of it needing it.

  12. Frances, enjoyed this post quite a bit and was referred to it by "Unlearning Economics", another really interesting blog.

    I had pondered some time ago some of the very things you write about here regarding the nature of money:

    I've struggled a bit with the "role of government" thing. I tend libertarian and have a fondness for the Austrian outlook, but utopian anarchy ideas strike me as, well, utopian and not at all in harmony with reality.

    The jubilee is the main thing at this point. But this is a tremendous readjustment and there will be a lot of problems. Not as many as we face otherwise, but good luck convincing people that that is the case.

    I've discussed the jubilee idea with Steve Keen quite a bit. He has a very different approach than the one I would take, probably because he's an economist and I'm a lawyer.

    But if you're interested in where a lawyer might go with all this, or at least this lawyer, you might take a look here:

    And here's how the government could keep functioning heartily and have money to lend:

  13. When you write of "too much debt" when debt-based systems malfunction, do you mean too much principal lent, or too much interest?

    The Bible does contain laws against usury, after all. I wonder whether limits on lending interest rates, or on total interest to be paid on a debt, would be a useful governmental control of a debt-based system.


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